Re-writing the History of the Housing Bubble and the Economic Crisis

The story of the housing bubble is an incredible tragedy. The collapse of the bubble has wreaked havoc on the lives of tens of millions of people by leaving them or family members unemployed, destroying savings and costing millions their homes.

The simple reality is bad enough, but what makes matters worse is that the whole episode was entirely preventable. As early as 2002 it was possible to recognize that house prices had sharply diverged from their long-term trend without any basis in the fundamentals of the housing market.

Since we had just seen the rise and collapse of a $10 trillion bubble in the stock market it should have been apparent to economists that our economy can generate large bubbles. The collapse of that bubble had thrown the U.S. economy into a recession, from which we were having considerable difficulty recovering, so it should have occurred to economists that the collapse of the housing bubble would also be bad news for the economy.

At least a few of us did recognize the housing bubble, and the dangers it posed at the time, and did everything we could to try to warn the country. For this reason it was somewhat shocking to see a book review in the New York Times by Noam Scheiber, an editor at the New Republic, that longed for the day when we will have people who can use data to identify housing bubbles before they grow so large as to pose a serious danger to the economy.

The personal slight is beside the point; the issue is that our elites are being allowed to construct an alternative reality that absolves them of responsibility for the ruined lives all around us. The reality is that people in positions of authority chose to ignore the evidence of a rapidly growing bubble and those trying to call attention to the dangers it posed. Instead we have Scheiber giving us the “who could have known story?” His case is that the dynamics of the bubble were just too complicated for people to grasp given the tools available at the time. The people who clearly warned of the bubble, using data, simply did not exist in Scheiber’s universe.

If it were just Scheiber saying this on a rant somewhere, he could be easily dismissed as a crank. While he is a prominent writer on policy and politics, prominent writers say ridiculous things all the times.

But this was not just a random rant. It was a book review in the New York Times, by far the nation’s most prestigious newspaper. It is a paper that employs fact checkers and prides itself on accuracy. Would the NYT allow a book reviewer to bemoan the fact that no one had questioned the existence of weapons of mass destruction in Iraq prior to the war?

And the bubble warners were not entirely below the NYT’s radar screen. In fact, several NYT reporters had picked up on warnings of the housing bubble (here and here). In fact, Paul Krugman, perhaps the most famous economist in the world, used his NYT column in 2002 to warn of the dangers posed by the housing bubble.

Given this history, how can an ill-informed book reviewer get away with making what is obviously an untrue assertion in an NYT book review? The simple answer is that Scheiber’s “who could have known” story is quite comforting to people with power in this country. The people in positions of authority who ignored the warnings of the dangers of the housing bubble would like the public to believe that there were no such warnings. It is much easier for them to act as though the state of economic knowledge was too primitive to allow them to see a bubble than to acknowledge that they simply did not feel like paying attention to the warnings.

It is important to their legitimacy to maintain this fiction, since with virtually no exceptions the people guiding economic policy today are the same people who ignored the growth of the bubble in the last decade. If everyone recognized the enormity of their failure they would be less likely to heed their calls for austerity: for example the cuts in Social Security and Medicare that virtually everyone in the higher circles of the policy establishment agrees are necessary.

That is why it is necessary to keep reminding the public that the policy elite blew it. The tools of economics were entirely adequate to see the housing bubble and the dangers that it posed to the economy. The problem is that the people who controlled economic policy at the time found it convenient to ignore the evidence. They still do.